Congress Appears Poised To Gut Government Contracts For Small Business

A provision in the Senate's National Defense Authorization Act appears to allow Pentagon contract officers to count subcontracts toward their goal for prime contracts to small businesses. (Photo by Charles Dharapak/AP)

M.L. Mackey and her husband started their company, Beacon Interactive Systems, 22 years ago. Since 2002, they have made their living primarily selling software to the Navy. As far as defense contractors go, theirs is a small business, to be sure: in the last 14 years, Beacon has booked almost $14 million in direct sales to the government, and done even more work as a subcontractor on other projects.

But recent work building shipboard operating software for energy management — a project, Mackey says, that has been "extremely well received from the waterfront to the Pentagon" — has led Mackey to think bigger. "We're actively transitioning our Navy products into maritime internet of things and manufacturing internet of things products," she said. The company, she says, has formed strategic partnerships to launch itself back into the private sector as a prelude to building an internal sales force. Meanwhile, she anticipates that within a few years, she'll be bidding on, and winning, much larger Navy contracts — worth as much as $15 million.

Mackey credits Beacon's success building the energy management software to a close working relationship with Navy program managers. "We were able to brainstorm and iterate directly with our fleet customer and develop a technology that directly addressed their needs," she says. "When they wanted to do more, they were able to directly engage with us. And we as a company have more of the I.P. we need to bring to the private sector market expansion. But none of this would have happened if I didn't have a prime contract."

It is precisely for this sort of reason that steering government contracts to small companies has been a cornerstone of federal economic policy for more than half a century. Federal agencies set goals for awarding prime contracts to small businesses generally — for the government as a whole, the goal is 23 percent — as well as smaller sub-goals for particularly struggling small business communities. Agencies must also make a separate set of goals for subcontracts made with small businesses by prime contractors — what are known as first-tier subcontracts.

All this, of course, is good politics for Congress; it's hard to name a legislator who got voted out of office for supporting small business. But now an overlooked provision in the Senate's version of must-pass bill turns the political calculus on its head and threatens sharp cuts to prime contracts for small business. The bill is the annual National Defense Authorization Act, and the provision, Section 838, appears to allow the Department of Defense to count many subcontracts made to small businesses against the agency's prime contract goals. The Pentagon spends 60 percent of all federal contracting dollars eligible to go to small businesses, and should the provision become law, total prime contracts from the federal government for small business could drop by as much as a quarter.

The provision would apply to certain very large Pentagon contracts known as major defense acquisition programs, and the change is needed in order to give small businesses a toehold in the biggest defense programs, according to Dustin Walker, a spokesman for the Republican majority on the Senate Armed Services committee, which wrote the bill. "There are no prime contracts for MDAPs going to small business — that’s $60 billion in contracts every year," Walker said in an email. "But to date, it has been very difficult to get small business participation in first- and second-tier subcontracts" as well. (Second-tier subcontracts are those made by first-tier subcontractors. Sophisticated defense systems can grow long chains of subcontracts.)

Last year, the Defense Department met most of its prime contracting goals, but fell short of most of its subcontracting goals, including its overall small-business subcontracting goal of 36 percent. "We hope this provision will make it more attractive for those businesses," Walker said.

Walker insisted that the provision does not undermine existing small business goals but simply requires separate accounting from the Pentagon. However, the 210 words of the proposed new section of law don't explicitly say that, and close observers of small-business contracting read them as allowing the Pentagon's contracting officers, who are under constant pressure to do more with less, to water down their prime contacting goals with subcontracts.

"If your goal is 22 percent, and there's a new pot of money available for reaching that goal, you're going to get to that 22 percent a lot quicker," said John Shoraka, who leads the Small Business Administration's government contracting office. "And once you get to 22 percent, how likely are you to put out more opportunities? And so I don't see how it wouldn't be negative for small business."

If the Pentagon were to take full advantage of the provision, under its existing subcontracting goals, it could replace as much as $22 billion in prime contracts with subcontracts. To put that in perspective, the agency's total contracts with small businesses amounted to $52 billion in 2015. Across the federal government, small companies received $91 billion in that year.

Mackey, for her part, said she'd be unable to hatch her big plans if she'd done the work as a subcontractor. "My team wouldn't have had the direct contact to more clearly understand the needs," she said. "Our products are always better when we work tightly with our customer." Moreover, subcontracting makes doing the work more expensive, because it adds layers of reporting and integration. And simply getting the work as a subcontractor, having lost the prime contract, becomes harder, she said. "We not only have to go and connect with and sell to our Navy partners, but we then have to go and do at all over again" with the company that got the contract. "It's essentially doubling our work effort."

"Subcontracting can be an important entry into the federal procurement world, especially for a nascent firm," said the S.B.A.'s Shoraka. "But once we start mixing the prime contracting world with the subcontracting world, it becomes a very slippery slope." In any event, because the federal government already counts first-tier subcontracts under the separate goal, it would surely mean a significant reduction in the total dollars flowing to small businesses.

The defense bill passed the Senate by an overwhelming margin, 85 to 13. The senators who voted in favor of the bill included Republican David Vitter of Louisiana, who chairs the Small Business committee and the committee's top Democrat, Jeanne Shaheen of New Hampshire. A spokesperson for Sen. Shaheen, Ryan Nickel, said in an email the senator "is concerned about the provision and is urging conferees to remove it from the defense bill." Sen. Vitter's office did not respond to repeated requests for comment.

The House version of the bill does not include this provision, and members from the two bodies are now hashing out a compromise bill, which is expected by the end of the year. But just because the provision didn't appear in the House version of the bill doesn't mean the House opposes it, said Nick Mikula, press secretary for the Republicans on the House Armed Services Committee. "It could just be the way the process shook out this year." Mikula said he couldn't comment on the status of the provision while the House and Senate negotiated a final version "because everything is up for grabs."

The White House has threatened to veto the Senate bill for a variety of reasons, but this section isn't one of them. But if the provision becomes law the S.B.A. may still have an ace up its sleeve. The agency, Shoraka pointed out, has a big role in setting other government agencies' contracting goals. If the Pentagon dilutes its prime contracting goal with subcontracts, then, said Shoraka, "guess what, your goal isn't going to be 22 percent anymore. Your goal is going to maybe be 30 percent."

I have reported on entrepreneurs, and the politics and policies that affect them, for The New York Times and Inc. magazine, among others, for more than a decade. I've also written about technology and public policy – particularly about renewable energy – for Discover and IEE...